Tag: Financial Statements

The Doctrine of Lifting the Corporate Veil is a significant concept in corporate law. It refers to a legal decision to treat the rights or duties of a corporation as the rights or liabilities of its shareholders or directors. Normally, a company is regarded as a separate legal entity, distinct from its shareholders, directors, or promoters, as established in the landmark case of Salomon v. Salomon & Co. Ltd. (1897). However, in certain situations, courts may “lift” or “pierce” the corporate veil to look beyond the company’s independent existence and examine the real individuals behind it.

This doctrine is applied when the corporate form is used to perpetrate fraud, evade tax, defeat law, or engage in dishonest practices. Indian courts have also accepted this principle to ensure justice and equity prevail over rigid legal formalities.

Purpose of the Doctrine:

The doctrine aims to:

• Prevent misuse of corporate personality.

• Hold the real persons accountable in case of fraud or illegal acts.

• Maintain fairness in the application of corporate law.

• Discourage unethical use of limited liability protections.

In essence, it is used to safeguard the public interest and ensure that the concept of limited liability is not abused.

Legal Basis in India:

In India, although there is no specific statute defining this doctrine, courts have developed it through judicial precedents under the Companies Act, 2013 and earlier company laws. Section 2(20) of the Companies Act defines a company as a separate legal person. However, Indian courts have exercised their inherent powers to disregard this separateness under specific circumstances.

Instances Where the Veil is Lifted

• To Prevent Fraud or Improper Conduct

If a company is formed or used to commit fraud, cheat creditors, or deceive the public, courts can lift the veil. In Delhi Development Authority v. Skipper Constructions (1996), the Supreme Court held that the veil could be lifted if a company was used as a facade for fraud.

• Evasion of Tax

Companies cannot be used as tools to avoid taxes. In Commissioner of Income Tax v. Meenakshi Mills (1967), the court lifted the veil to investigate tax evasion and found that the company was used to divert income.

• Avoidance of Welfare Laws

If a company is set up to escape compliance with labour or social welfare laws (like PF, ESI), courts may disregard the corporate entity. This ensures that employers do not hide behind the veil to deny workers their rightful dues.

• Agency or Sham Companies

Where a company is a mere agent of another person or company, and does not function independently, the veil may be lifted. Courts will then attribute actions or liabilities of the company to the real controller.

• Protection of Public Interest

Courts lift the corporate veil when it is necessary to protect national interest, prevent illegal trade, or uphold security and law. For example, in LIC v. Escorts Ltd. (1986), the court analyzed the shareholding of foreign companies to determine control and ownership, for the sake of public policy.

Statutory Provisions Under the Companies Act, 2013:

While the Companies Act does not directly mention “lifting the veil,” certain provisions indirectly support the doctrine:

• Section 7(7): If the company is incorporated by furnishing false or incorrect information, the liability can be imposed personally on the persons responsible.

• Section 34 and 35: Penalties for misstatements in the prospectus can make directors and promoters personally liable.

• Section 339: In case of fraud during winding up, the Tribunal may hold the persons who were knowingly parties to the fraud personally liable for company debts.

Judicial Interpretation and Landmark Cases in India:

1. Salomon v. Salomon & Co. Ltd. (UK case, 1897)
   Established the principle of separate legal entity.

2. Life Insurance Corporation of India v. Escorts Ltd. (1986)
   Explained that lifting the veil depends on the facts and must be applied cautiously.

3. Gilford Motor Co. v. Horne (UK case)
   The veil was lifted to prevent an ex-employee from using a company to breach a contract.

4. Union Carbide Case (Bhopal Gas Tragedy)
   The Indian government tried to lift the veil of Union Carbide Corporation to hold it responsible for the actions of its Indian subsidiary.

Limitations of the Doctrine:

While the doctrine is important, courts use it sparingly and cautiously. It is not meant to disregard the corporate structure in every dispute. Courts generally uphold the sanctity of the corporate form unless there is strong evidence of misuse, fraud, or illegal conduct. The doctrine cannot be used merely to satisfy debts or liabilities when no wrongdoing is involved.

Book building is a price discovery mechanism that is used in the stock markets while pricing securities for the first time. When shares are being offered for sale in an IPO, it can either be done at a fixed price. However, if the company is not sure about the exact price at which to market its shares, it can decide a price range instead of an exact figure. This process of discovering the price by providing the investors with a price range and then asking them to bid on it is called the book building process. It is considered to be one of the most efficient mechanisms of pricing securities in the primary market. This is the preferred method which is recommended by all major stock exchanges and as a result is followed in all major developed countries in the world.

Book Building Process:

• Appointment of Investment Banker:

The first step starts with appointing the lead investment banker. The lead investment banker conducts due diligence. They propose the size of the capital issue that must be conducted by the company. Then they also propose a price band for the shares to be sold. If the management agrees with the propositions of the investment banker, the prospectus is issued with the price range as suggested by the investment banker. The lower end of the price range is known as the floor price whereas the higher end is known as the ceiling price. The final price at which securities are indeed offered for sale after the entire book building process is called the cut-off price.

• Collecting Bids:

Investors in the market are requested to bid to buy the shares. They are requested to bid the number of shares that they are willing to buy at varying price levels. These bids along with the application money are supposed to be submitted to the investment bankers. It must be noted that it is not a single investment banker who is engaged in the collection of bids. Rather, the lead investment banker can appoint sub-agents to tap into their network especially for receiving the bids from a larger group of individuals.

• Price Discovery:

Once all the bids have been aggregated by the lead investment banker, they begin the process of price discovery. The final price chosen in simply the weighted average of all the bids that have been received by the investment banker. This price is declared as the cut-off price. For any issue which has received substantial publicity and which is being anticipated by the public, the ceiling price is usually the cut-off price.

• Publicizing:

In the interest of transparency, stock exchanges all over the world require that companies make public the details of the bids that were received by them. It is the lead investment banker’s duty to run advertisements containing the details of the bids received for the purchase of shares for a given period of time (let’s say a week). The regulators in many markets are also entitled to physically verify the bid applications if they wish to.

• Settlement:

The application amount received from the various bidders has to be adjusted and shares have to be allotted. For instance, if a bidder has bid a lower price than the cut-off price then a call letter has to be sent asking for the balance money to be paid. On the other hand, if a bidder has bid a higher price than the cut-off, a refund cheque needs to be processed for them. The settlement process ensures that only the cut-off amount is collected from the investors in lieu of the shares sold to them.

Partial Book Building

Partial book building is another variation of the book building process. In this process, instead of inviting bids from the general population, investment bankers invite bids from certain leading institutions. Based on their bids, a weighted average of the prices is created and cut-off price is decided. This cut-off price is then offered to the retail investors as a fixed price. Therefore, the bidding only happens at an institutional level and not at a retail level.

This is also an efficient mechanism to discover prices. Also the cost and complications involved in conducting a partial book building are substantially low.

First of all, the book building process brings flexibility to the pricing of IPO’s. Prior to the introduction of book building, a lot of IPO’s were either underpriced or overpriced. This created problems because if the issue was underpriced, the company was losing possible capital. On the other hand, if the issue was overpriced it would not be fully subscribed. In fact, if it was subscribed below a given percentage, the issue of securities had to be cancelled and the substantial costs incurred over the issue would simply have to be written off. With the introduction of book building process, such events no longer happen and the primary market functions more efficiently.

Other Subtypes of Book Building

The following are subtypes of book building:

• Accelerated Book Building

The companies can use an accelerated book-building process to acquire quick capital market. That can be the case when a company cannot finance its short-term project via debt financing. So, the issuing company contacts several investment banks that can act as underwriters the evening before the intended placement. Under this process, the offer period is open only for a day or two days, and you have no time for marketing for an issue. So, instead, the underwriter overnight contacts their networks and details the current topic to institutional investors. If this investor finds this issue interesting, then allotment happens overnight.

• Partial Book Building

As the partial book building says, that issue book is built partially, where the investment banker only invites bids from the selected investors. Based on their bids, they take the weighted average of the prices to finalize the cut-off price. Then other investors, such as retail investors, take this cut-off price as a fixed price. So, the bidding happens with a selected group of investors under the partial book-building process.

Advantages of Book Building

• The most efficient way to price the share in the IPO market.
• The share price is finalized by investors’ aggregate demand, not by the fixed price set by the company management.

Disadvantages of Book Building

• High costs are involved in the book-building process compared to the fixed-price mechanism.
• The period is also more in the book booking process than the fixed-price mechanism.

Subscription of shares refers to the process where investors apply for shares issued by a company. When a company offers shares to the public through an Initial Public Offering (IPO) or other methods, investors submit applications to purchase them. Based on demand, the company may receive full, over, or under-subscription. Full subscription means the exact number of shares offered is applied for, over-subscription occurs when demand exceeds supply, and under-subscription happens when applications are fewer than the issued shares. Companies allocate shares based on predefined criteria, ensuring fair distribution among investors while adhering to regulatory guidelines.

Minimum Subscription of Shares:

The minimum subscription of shares refers to the minimum number of shares that a company must sell to raise a certain amount of capital to proceed with an issue, whether through an Initial Public Offering (IPO), Follow-on Public Offering (FPO), or any other public offering. This minimum subscription amount is typically defined in the prospectus and is a regulatory requirement, ensuring that the company has sufficient investor interest to justify proceeding with the issue.

In India, for instance, the minimum subscription requirement for public offerings is usually 90% of the total issue size. If the company fails to achieve this minimum subscription level, the issue is considered unsuccessful, and the funds collected (if any) must be refunded to the investors. This safeguard protects investors from getting involved in companies that may lack sufficient investor confidence or face difficulties in raising the required capital.

The concept of minimum subscription ensures that the company has a strong foundation of capital to fund its operations or expansion. It also prevents situations where the company might not have enough funds to cover operational or project expenses, thus providing a level of financial security.

Moreover, achieving minimum subscription enhances the credibility of the company in the eyes of investors and regulators, as it demonstrates market confidence in its business model and financial stability.

Over-Subscription of Shares:

Over-subscription occurs when the demand for shares in an initial public offering (IPO) or any other public share issue exceeds the number of shares offered by the company. This situation indicates high investor interest in the company’s shares, often due to favorable market conditions, strong company performance, or investor confidence in the business’s future prospects.

When an issue is over-subscribed, investors apply for more shares than what is available. For example, if a company issues 1,00,000 shares, and investors apply for 2,00,000 shares, the issue is considered over-subscribed by 100%. This scenario usually results in the company having to make decisions on how to allocate shares fairly among investors.

In cases of over-subscription, companies may use various methods to allocate shares, such as:

1. Pro-rata Basis: Shares are allocated in proportion to the number of shares applied for by each investor. If an investor applied for 100 shares and the issue was over-subscribed by 2:1, they would receive only 50 shares.

2. Lottery System: In some cases, especially when demand far exceeds supply, a lottery system is used to randomly allocate shares to applicants.

3. First-Come, First-Served: Shares may be allotted based on the order in which applications are received, with early applications being given priority.

Under Subscription of Shares:

Under subscription occurs when a company issues shares to the public, but the total number of shares applied for is less than the number offered. This indicates low investor demand, possibly due to high pricing, poor market conditions, or weak company reputation. Unlike oversubscription (excess demand), under subscription means the company fails to raise the intended capital.

To resolve this, companies may extend the subscription period, revise the offer price, or rely on underwriters (if any) to purchase the remaining shares. If the minimum subscription (as per regulatory requirements) is not met, the issue may be canceled, and application money refunded. Under subscription can negatively impact the company’s market perception and future fundraising prospects.

Features of Under Subscription:

• Lower Capital Raised

Under subscription means the company cannot collect the full projected capital, forcing it to seek alternative funding (e.g., loans, private placements). This may delay expansion plans or increase financial risk due to reliance on debt.

• Underwriter’s Role Becomes Critical

If shares are underwritten, the underwriter must purchase the unsubscribed shares, ensuring the company receives the intended funds. This safety net comes at a cost (underwriting commission).

• Regulatory Compliance Issues

Companies must meet minimum subscription requirements (e.g., 90% in some jurisdictions). Failure may force refunds and cancellation, requiring re-filing with regulatory bodies (e.g., SEBI, SEC).

• Negative Market Sentiment

Low subscription signals weak investor confidence, potentially lowering share prices in secondary markets. It may also affect future IPO prospects and credit ratings.

• Extended or Revised Offer

Companies may reprice shares or extend the subscription period to attract investors. However, this delays capital availability and increases administrative costs.

• Impact on Share Allotment

Since demand is below supply, all applicants receive full allotment (no proportional distribution). This contrasts with oversubscription, where allotment is partial.

The organization primarily looks after the operation of employment exchanges, industrial training institutes, vocational guidance programme and some other institutions. The activities of the directorate are essentially governed by the policies, standards and procedures set by the central directorate general, employment and training. Other activities of the organization include employment market information, vocational rehabilitation centers, and training of handicapped groups such as women and physically handicapped. The training wing of the department also looks after the implementation of the apprentices act, 1961. Generally, the directorate functions independently of the organizing of labour commissioner.